1
Korea-China FTA as a Catalyst for Fostering the Intra-industry
Specialization with Agglomeration Effect
Hae-du Hwang, Yonghee Lee and Sungchul Bang*
Abstract
Previous studies on the FTA between Korea and China argue that technology-intensive manufacturing
sectors procure some benefits from the trade creation effect and dynamic one whereas small-and-medium
enterprises and agricultural sectors incur some costs of industrial adjustment. This research recapitulates
the industrial adjustment policy of Korea by supplementing the agglomeration effect of new economic
geography and the new attributes of FTA. The analysis on the trade and investment of manufacturing
demonstrates that it may be imperative for Korea to pursue the intra-industry specialization with China by
fully taking into account the reduced technology gap. Its policy implications based on the SWOT analysis
on automobile and the trade specialization index analysis on ancillary industry comprise the joint
operation of human resource development and R&D activities as a means of accruing the cumulative
causation effect between market expansion and technology innovation.
Keywords: FTA, intra-industry specialization, industrial adjustment policy
agglomeration effect, new economic geography
JEL codes: F15, L62, O14
-----------------------* Hae-du Hwang, Professor of Department of International Trade, College of Commerce and Economics
and Director of Seoul European Institute, Konkuk University, Phone: 82-2-450-3653, Fax: 82-2-34376610, First author, E-mail : Haedu.Hwang@konkuk.ac.kr; Yong-hi Lee, Visiting Researcher, Seoul
European Institute, Second author; Sung-chul Bang, Doctoral Candidate, Department of International
Trade, Konkuk University We are grateful for the helpful comments of Dr. Chul Cho of the Korea
Institute for Industrial Economics & Trade on automobile industry. This research is partially funded by
the research grant from the Konkuk University.
2
I. Introduction
In accordance with the summit agreement between China and Korea in 2004, a joint research on the
feasibility study of Korea-China FTA (KCFTA) was launched in 2005. The impact of KCFTA to the
Korean economy may outweigh that of Korea-U.S. FTA if one takes into account the fast pace of trade
and investment expansions between Korea and China.1 This paper aims at formulating the industrial
adjustment policy of Korea to cope with the intra-industry specialization for launching KCFTA.
1. 1 Trade and Investment Flows between Korea and China
China was the largest trade partner of Korea in 2008 as shown in Table 1. Major export items of Korea
to China were semiconductors, computers, wireless communication equipments which took about 39 per
cent of total exports to China in 2006. Major import items of Korea from China are computers,
semiconductors and steel products which took about 35 per cent of total imports from China.
As pointed out by Yang and et. al. (2007), most Korean firms have contributed for the export
expansion of raw materials and intermediate goods to China. The electric and electronics items,
transportation equipments, steel products and leather and footwear goods produced by Korean affiliates in
China have shown a high ratio of imported intermediate goods from Korea. But foodstuffs and groceries
as well as non-ferrous materials produced by Korean affiliates have exhibited the opposite trend of using
relatively high ratio of local content. Chemical products, which heavily depend on the intermediate goods
with lower price tags, also exhibit similar patterns of high ratio of local content.
[Table 1] Relative Shares of Major Trading Partners of Korea in 2008
China
EU
United States
Japan
Total
Export Import Export Import Export Import Export Import Export Import
Billion US $
914
769
584
400
464
384
283
610 4,220 435.3
Share (%)
21.7
17.7
13.8
9.2
11.0
8.8
6.7
14.0
100
100
Source: Korea International Trade Association, http://kita.net
The increasing trend of trade surplus of Korea with China has been slowed down since 2005 as shown
in Table 2. The average expansion rates of trade was 36.1 per cent over the period 2002-2004, but it
declined to 26.7 per cent in 2005 and further declined to 17.4 per cent in 2006. One noticeable
1
The cabinet research center of China and Korea International Economic Policy Institute resumed this task and the final report is
scheduled to be published by the end of 2009
3
phenomenon was that the growth rates of Korean imports from China overwhelmed those of Korean
exports to China since 2005. The subsequent reduction in trade surplus may be derived from the
displacement of Korean exports with the Chinese exports and the fast pace of catch-up of China. Korea
ranked the fourth position by occupying 4.6 per cent of total exports of China after the United States
(19.1 per cent), Hong Kong (15.1 per cent) and Japan (14.0 per cent). It ranked the second post by
occupying 10.6 per cent of total Chinese imports in 2007 after Japan.
The outbound FDI of Korea to China increased from 0.6 billion US dollars in 2001 to 3.3 billion US
dollars in 2006. It has been heavily concentrated on the manufacturing sector and individual FDI are
rather small magnitude in amount. The recent development is its increase in the relative share of FDI
extended to the service industry whose share reached up to 17.7 per cent of total outbound FDI to China
in 2006.
[Table 2] Korea’s Trade Balance with China (unit: million US dollars)
1990
1995
2000
2004
2005
2006
2007
Export
585
9,144
18,455
49,763
61,915
69,459
81,985
Import
2,68
7,401
12,799
29,585
38,648
48,577
63,028
Trade Surplus
-1,683
-1,743
5,656
20,178
23,267
20,902
18,957
Source: same as Table 1
The outbound FDI of China to Korea had been virtually meager before 2000, but it has been increased
at a fast pace since then. Its magnitude had been reached to the amount of 0.6 billion US dollars in 2004
which took account of 9.11 per cent of total inbound FDI into Korea. But it had been reduced to the
amount of 0.1 billion US dollars in the following two years. Its cumulative amount recorded 1.6 billion
US dollars by the end of 2007 which was approximately 8.5 per cent of the total cumulative amount of
inbound FDI into Korea which recorded 18.7 billion US dollars.
1.2 Recent Progress in Launching FTA of China and Korea
Both China and Taiwan had belonged to the exceptional cases for not having launched any FTA among
those economies whose economic magnitudes are classified within the range of world 30th rankings before
their accession to the WTO in 2001. But China pursues FTA with a positive stance since it became the
Signatory of WTO (Hwang and Yin, 2008).2 It has launched FTAs with Hong Kong, Macao, the ASEAN,
2
Taiwan also became the Signatory of WTO at the same time.
4
Chile, Pakistan, New Zealand, Singapore and Peru. 3 It is currently negotiating FTAs with Gulf
Cooperation Council (GCC), Australia, Iceland, Norway, South African Customs Union and Costa Rica.
It has also launched the Shanghai Cooperation Organization with Russia, Kazakhstan, Kyrgyzstan,
Tajikistan and Uzbekistan in 2007 as a collective defense system. China seems to attach more emphasis
on the aspect of international relations than economics.4 Chambers (2005, p. 599) argues that the best
explanation on the evolution of the Sino-Thai friendship rests on the desire of both countries to maintain
the mutually beneficial partnership, in particular Thailand’s role as a link or facilitator between the
People’s Republic of China and ASEAN. China has been quite positive in liberalizing the manufacturing
sector on which it has strong competitive edges. But it seems to adopt a step-wise approach on the
liberalization of service industry despite its recent firm commitment.
Korea has launched FTA with Chile, Singapore, the EFTA and the ASEAN and completed FTA
negotiation with the United States in April 2007. It finalized the Comprehensive Economic Partnership
Agreement (CEPA) with India in August 2008 and is almost on the verge of finalizing FTA negotiation
with the EU. Korea prefers to have a comprehensive FTA which covers not only tariff reductions but also
liberalization on service and investment. It also attaches priorities to those nations to which Korea can
increase its net exports.
II. Previous Studies on the Effect of KCFTA
1. Tariff and Non-tariff Barriers
The nominal tariff rate of China in 2006 was 9.8 per cent 5 which was below the corresponding figure
of 11.9 per cent of Korea. According to the study done by Yang and his colleagues (2007, pp. 108-112),
the adjusted average tariff rates based on import amount between Korea and China in 2006 were 7.29 per
cent for Korea and 4.54 per cent for China. The corresponding tariff rates on manufactures were 4.62 per
cent for Korea and 4.49 per cent for China respectively. Both nations maintain the tariff escalation
structure on the different stages of production. For instance, China levies 7.7 per cent tariff rate on parts
or components while imposing 15.0 per cent tariff one on consumer goods. The escalation of adjusted
tariff rates implies that Korea exports intermediate goods to China whose tariff rates are lower than Korea
whereas China exports consumer goods and agricultural products to Korea whose tariff rates are
relatively higher than those of China. The trade-adjusted tariff rates of China have been low because most
raw or semi-processed materials imported from Korea are exempted from tariff levies. Furthermore, the
system of tariff refund is available when the final Chinese goods are exported to Korea. But the
exceptional cases, in which trade-adjusted tariff rates of China are higher than those of Korea, comprise
3
China also has launched the Asia-Pacific Trade Agreement which is the outgrowth of Bangkok Agreement with the ASEAN.
China sometimes make light of the economic aspects of FTA. It may want to improve its relative position or influence on the
Southeast Asia..
5
This refers to the HS 8-digit MFN applied average tariff rates of China.
4
5
automobile and its ancillary items, cosmetics, non-metallic ores and steel-related products. The tradeadjusted tariff rates on textiles and woven fabrics are relatively high in both countries.
China has reinforced a wide range of NTBs such as anti-dumping duties, tariff-rate quotas, the limited
import permissions on the automobile and its ancillary items via designated ports, the restrictions on
foreign firms which participate on government procurements and exclusive compliances on the domestic
medical codes for screening medical equipments. But the AD duties of China have exerted one of the
most influential impacts on the manufactures exports from Korea. The litigation of Chinese AD duties on
imported items from Korea reached 28 cases of total 47 ones over the period 1997-2006, which recorded
about 60 per cent of total Chinese ADs. Most ADs of China on Korean manufactures are heavily
concentrated on the petro-chemical products and steel-related ones6 on which the shares of Korean
exports to China to the total world export at the sector specific levels are relatively high. These ratios
were about 45.5 per cent and about 32.0 per cent respectively for the petro-chemicals and steel-related
products in 2006.
2. Different Assumptions on KCFTA and Their Effects on Macroeconomics
Both Korea Institute for International Economic Policy (KIEP) and Korea Institute for Industrial
Economics & Trade (KIET) adopt the Global Trade Analysis Project (GTAP) model for the
macroeconomic analysis of KCFTA. The GTAP model is designed for the quantitative analysis for the
impact of trade policies from the viewpoint of world economy by making use of GTAP-DB which can
accommodate the general equilibrium analysis based on the multi-region and multi-sector model. There
are no fundamental differences in their methodologies except for the differences with respect to the data
base, the assumptions on the tariff exemptions and the industrial classification.
The KIEP research assumes not only the total abolition of tariff barriers in the manufacturing and
agricultural sectors but also the reduction of non-tariff barriers in the service sector by substantiating tariff
equivalents. The KIET takes more or less the same stance on the tariff removals but it does not cover the
possible reduction of non-tariff barriers. The KIEP estimates the effect of actual tariff removal for the
year of 2001 whereas the KIET measures the same effect in 2005 for Korea and in 2004 for China.
The static analysis of the KIEP forecasts that the GDP will be increased about 2.44 per cent for Korea
and 0.40 per cent for China. The corresponding figures of the KIET research are 0.18 per cent and 0.04
per cent respectively. Both researches demonstrate that the KCFTA will bring forth increases in GDP and
economic welfare. The estimated economic effect is larger for Korea because the trade dependence ratio
of Korea is higher than that of China. The forecasts of the KIEP, which adopt more proactive assumptions
on the reduction of trade barriers, are larger than the corresponding ones of the KIET. The dynamic
Computable General Equilibrium (CGE) model, which reflects the capital accumulation, shows slightly
higher growth rates than the projected growth rates in the static CGE model. The growth rates of GDP
6
Most AD duties levied on Korean manufactures by the EU have been the household electronic goods.
6
projected by the KIEP for Korea and China are 3.13 per cent and 0.58 per cent respectively. The
corresponding figures of the KIET are 1.08 per cent and 0.18 per cent respectively.
3. Effect of KCFTA on the Manufacturing Sector
The share of automobile, electronics, general machinery, textile and clothing, steel and petro-chemical
products was approximately 77 per cent of total Korean exports in 2007. The corresponding figure for
China was about 67 per cent.7 For instance, the export amount of Korean petro-chemical items to China
was 8.07 billion US dollars in 2006 whose relative share was about 45.5 per cent of total petro-chemical
exports of Korea. The share of manufacturing sector to GNP of Korea increased from 23.7 per cent to
24.8 per cent and that of China increased from 44.8 per cent to 48.6 per cent over the period 2002-2007.
The output of Chinese steel industry takes account of 30.9 per cent of world output and 7.5 per cent of
world exports in 2005 (IISI, 2006). The Chinese steel industry has procured price competitiveness on
ordinary products by making use of the largest capacity in the world since 1996. A substantial part of
Korean exports of steel products to China is used for the processed trade whose share is about 56.1 per
cent whereas the corresponding share of exports to the Chinese domestic market is about 39.9 per cent in
2007. The Korean exports of steel products are expected to be increased if the KCFTA is launched.
But there emerge three detrimental factors on this mega-trend. One factor is the rapid pace of
technology catch-up of China which may reduce its manufactures imports from Korea. Another one is the
relatively high trade-adjusted average tariff rates of Korea as compared to those of China. The Chinese
exports of manufactures to Korea are expected to be increased with a faster pace than those of Korea to
China. The last one may be the relatively high growth rates of China which bring forth the parallel
enhancement of competitive edges by realizing incessant flows of income for new investment for
production capacity, R&D and marketing strategy. The growth rates of China since the global financial
crisis in 2008 declined below the two digit numbers per annum. But its reduced growth rates of 9.0 per
cent per annum in 2008 are still far above the corresponding figure of 1.5 per cent of industrialized
countries. The expanding domestic market boosted by these high growth rates, which keeps a certain
distance from credit crunch,8 also breeds vitality to the Chinese economy. It may be a due time for Korea
to have a cool contemplation on the overall configuration how to formulate its corporate strategy and
public policy to cope with the dynamic challenge from China.
4. Effect of KCFTA on the Agriculture, Service and Investment Activities
The agricultural sector belongs to one of those sectors which may incur enormous adjustment costs
caused by the launch of KCFTA. China had been the largest trade partner of Korea in the realms of
agricultural products, livestock items and fisheries whose shares among total Korean imports was about
7
Korean International Trade Association, http://stat.kita.net
This may be stemmed from the on-going phenomenon that the Chinese financial system is rather immune to the global financial
crisis and its contagion due to its firm grip on capital movements and the big accumulation of foreign exchange reserves.
8
7
22.8 per cent in 2005. The proxy respective shares to total Korean imports are 23.8 per cent for
agricultural products, 3.0 per cent for livestock items and 39.3 per cent for fishery items. The general
price level of agricultural products of China is about 6.5 times lower as compared with that of Korea due
to the much cheaper production cost in China. The average production cost of Korean agriculture is
approximately 9.7 times expensive than the corresponding cost of China.9
The launch of KCFTA is expected to bring forth a remarkable progress in the liberalization of the
service sector because both governments are pursuing the liberalization procedures in the service sector.10
The risk factors of FDI will be reduced in parallel with the fortification of liberalization commitment and
transparency. This movement will stimulate the trade and investment in the service sector between these
two nations which will enhance the competitive edges of the manufacturing sector. If the negative system
is adopted in the KCFTA, this will induce Korean firms to expand their entries into the service sector as
well as their FDI to China by fully acknowledging the increased legal stability. Lee (2007, p.67) argues
that it may be necessary for Korea to facilitate the liberalization of service sector as a means of
stimulating the knowledge-intensive service sectors which brings forth high growth rates boosted by
spillover effect of leaning-by-doing in high value-added contents.
III. New Attributes of FTA and Increased Leverage of Agglomeration Effect
1. New Attributes of FTA
A comprehensive multilateral norm, which can govern the FDI, is still unavailable. The principles
related with the investment transactions initiated by the OECD have been adopted as an alternative of
multilateral norms. But the United States maintained the imperative need for the GATT to formulate and
implement such a normative criterion on FDI whereas developing countries were rather reluctant to
accommodate this proposal. Trade negotiators at the UR have, somehow, achieved a little progress in
making international norms within the boundary of the trade-related investment measures (TRIM) by
taking into account the sluggish progress on reaching the multilateral agreement of investment (MAI) at
the OECD. The TRIM and the General Agreement on Trade in Services (GATS) are the very outcomes of
such endeavors. Since the collapse of MAI proposed by the OECD 11 in 1998, the development of
international norms on FDI can be interpreted as an extension of the liberalization principles of
investment flows developed by the OECD. It is noticeable that a substantial part of FDI has been covered
by the FTA negotiations due to the limited maneuvering range of the TRIM or GATS of the WTO.
Despite its resumption in December 2007, the DDA has been derailed in resolving such pending issues
in the agricultural and service sectors. Most industrialized nations put high priorities on the liberalization
9
The main reasons for the cost differences are the relatively cheap wage rates and virtually no rental cost for cultivating the land.
The abolition of the ceilings on representative office numbers of foreign law firms and the numbers of lawyers well exemplify
such cases.
11
This failure may be stemmed from the special attribute of FDI channeled into developing countries which can be interpreted as an
extension of the North-South problems between the investing and hosting countries
10
8
of the service sector as a means of scooping their shares in the lucrative service market. The United States
and the EU are no exceptions on this mega-trend. Beside the addition of investment and service issues,
FTA is used as a preemptive entry for accruing the benefits of FTA or a means of sterilizing the benefits
of incumbent FTA membership of competing nations.
2. Increased Leverage of Industrial Adjustment and Agglomeration Effect
Cowling and Suden (1996, p. 289) point out that European unemployment is partly influenced by the
activities of the multinational enterprises (MNEs) if one fully takes into account the increasing dominance
and changing patterns of trans-nationally organized production. Under these circumstances, an
expansionary demand management policy may successfully reduce the unemployment rates in the short
run, but it does not provide any viable long-term solution. Neither will the traditional supply-side policies
such as organizational reshuffling or technological innovation. It may be rather imperative to address the
unemployment issue from the viewpoint of strategic approach of shaping a new configuration on the
industrial structure by taking into account the technology map and marketing strategy of MNEs.
Previous studies on the Korea-US FTA and KCFTA attach prime importance to the welfare gains. The
industrial adjustment process has been treated with secondary one. But the new economic geography
(NEG) sheds light on the critical importance of industrial adjustment as a means of achieving the intraindustry specialization. It may be a due time for Korean entrepreneurs and policy-makers to formulate the
corporate strategy and public policy in order to capture a pivotal momentum for realizing the synergistic
effect of technology innovation and global marketing.
The NEG puts forward the importance of agglomeration effect by pointing out the fortified competitive
edges on the spatial basis such as the Silicon Valley for IT industry, the Northern Italy for fashion
industry and the borders between Germany and Switzerland for pharmaceutical industry. It is different
from the conventional or alternative trade theory, such as the Heckscher-Ohlin trade theory or the intraindustry trade one, by emphasizing the cumulative causation effect between technology innovation and
market expansion in the context of making use of the spillover effect of spatial factors such as
geographical advantage, quality of migrant workers and agglomeration of economic activities. Duranton
and Storper (2006) posit that geographers emphasize human diversities, local amenities, firm
heterogeneity and location whereas economist stresses technological externalities, linkage effects,
technology innovation and market access. The agglomeration effect is mainly derived from the mutual
interaction between technology innovation and market expansion by making use of the proximities of
production locations. Economic activities with certain distances are not covered or discussed in the NEG.
But such a gap of spatial distances may be bridged or overcome by operating FDI by making use of the
advantages of the organization, the location and the internalization organization. The tacit knowledge
network may also work as a facilitator for realizing the agglomeration effect from such FDI.
9
IV. Industrial adjustment Policy of Korea towards the KCFTA
1.
Comprehensive Approach and Intra-industry Specialization for Accruing Agglomeration
There has emerged a proliferation of FTAs as most nations prefer to launch FTAs which is relatively
easy for them to reflect their interests by accommodating the new attributes of FTA. It is the United States
which has pushed forward the launch of WTO for the trade liberalization focused on the agricultural and
service sectors since the late 1980s. It is the U.S. which initiates the launch of FTAs since the late 1990s
in order to expedite trade liberalization on those items with leading global market positioning. It is also
the U.S. which firstly implements the bail-out measures for the ‘Big Three’ since the eruption of global
financial crisis in September 2009. The immediate reaction of French government is to increase its
ceilings on sales guarantee to the motorcar producers and similar measures have been also adopted by
other industrialized and emerging economies. Both Korea and China has joined such tentative schemes
for revitalizing the automobile industry by providing cross subsidies.
Palley (2006) maintains the shift of the export-oriented industrialization of China toward a domesticoriented one as a means of alleviating trade imbalance between the U.S. and China. He also adds that the
scale of Chinese exports has been contributing to the massive U.S. trade deficit by undermining the U.S.
manufacturing industry. The agglomeration effect may become more important in the context of the
global imbalance because it has a self-reinforcing mechanism between the procurement of stable market
and technology innovation which in its turn may contribute for the alleviation of such an imbalance.
Lee (2009, p. 181) points out that the global financial crisis of 2008 differs from the financial crisis of
East Asian countries in 1998 in that asymmetries between U.S. as a debtor with key currency privilege
and other debtors without the original fortune are observed. It is further noticed that the present
asymmetries would be alleviated only when U.S. becomes even bigger debtor with the crisis not only to
other nations but to itself. The agglomeration effect may exert more leverage effect in the context of the
on-going volatile credit crunches and consumer ones which may be doomed to prevail in the forthcoming
decade. This is because nobody knows exactly to what extent the outside money12 has been come into
being and circulated due to the widespread activities of private equities and hedge funds since the early
1980s as compared with the conventional monetary total which can be matched by the asset of central
banks. Such extra international liquidities, somehow, have bridged the trade and budget deficits of the
U.S. for nearly three decades.
The U.S. has endeavored to launch FTA with the Northeast Asian countries with an aim of sterilizing
the massive movement of Chinese exports toward Eastern direction as well as increasing its exports and
FDI to this region. The emerging regionalism in Northeast Asia seems to steer its direction for setting up
a defensive mode, e.g., the swap agreements on foreign exchange reserves and petroleum buffer stocks at
12
The outside money is the net liability of central bank to other economic agents whereas the inside money is the liability of central
bank exactly offset by the asset of central bank. .
10
the initial stage. It may shift toward the mode of a preemptive initiative in trade and investment as well as
common energy policy if they successfully reach an overall consensus to accommodate federal elements.
The agreement of the ASEAN plus three in May 2009 to expand the Chiang Mai Initiative (CMI) fund13
up to the amount of 120 billion US dollars may interpreted as an intermediate level between the defensive
and preemptive mode. As pointed out by Hwang and Andreosso-O’Callaghan (2009, p 65), it may be
rather imperative for Northeast Asia to reinforce the processes of energy cooperation and economic
integration simultaneously if one fully takes into account of the development strategy of the European
Coal and Steel Community.
It is gathered that both entrepreneurs and policy-makers around the world in 2009 are ready to
reinforce a combination package of corporate strategy and public policy to pursue more effective global
and/or regional marketing in the context of the complicated mixture of globalization, regionalism and
sporadic government interventions. Under these circumstances, the strategic approach plays critically
important role of shaping national or regional competitive edges because such an approach to FTA is
formulated not only by those factors of trade, FDI and technology acquisition and diffusion but also by
the new added elements such as industrial adjustment policy, R&D policy, human resource development,
and international relations.
There has emerged a cut-throat competition in the petro-chemical and steel-related industries due to the
increase in the excess capacity around the world. China attaches high priorities for enhancing industrial
structure of petro-chemical and steel industries. Hwang and Andreosso-O’Callaghan (2009, pp. 76-79)
illustrate that China has already captured the up-stream of petro-chemical industry by purchasing the oil
field and refinery plants in Iran, Central Asia and Latin America. All three leading national enterprises of
China, CNPC, CNOOC and SINOPEC, have endeavored to explore the energy sources around the world
with a full collaboration with the summit meetings. The self-sufficiency ratios for oil of Korea and China
in 2006 were 3.2 per cent and 26.0 per cent respectively (IEA, 2007). Despite having kept a revealed
comparative advantage wit China, the share of Korean exports in the Chinese petrochemical market had
been shrank from 26.1 per cent to 18.0 per cent over the period of 2001-2005 (Hwang, 2006).
The implementation of ADs by China on the petro-chemical and steel-related items may be a transitory
phase of the Chinese industrial policy until these industries procure competitive edges by achieving
technology acquisition and diffusion in the near future. It is also expected that these industries replace the
imports of raw materials and intermediate goods by further carrying out import substitution
industrialization. It may be necessary for Korea to formulate a long-range planning in the industrial
adjustment policy in order to enhance its competitive edge without incurring unduly high frictional cost of
trade disputes with China.
13
The CMI refers to a network of bilateral swap agreements created by ASEAN plus Three in May 2000 as a means of providing
shot-term liquidity assistance.
11
The intra-industry specialization has become more important if one fully perceives the critical
importance of maintaining the core competencies which are shaped by the effective amalgamation on the
economies of scale, product differentiation and architectural capability as exhibited in the fortification of
vertical integration by building steel plants near the iron ore mining sites (Park, Huh and Lee, 2008). The
exploration and capitalization of the steel mines or oil fields have become indispensable ingredients for
increasing the leverages of market power of relevant firms. China is far ahead of Korea in capturing the
up-stream of petroleum, natural gas and steel industries. The drastic decline in trade surplus with China
indicates that China may have successfully reduced or closed the technology gap with Korea. China has
not only reduced such a technology gap with for the textile and clothing industry, and steel industry with
Korea but also fortified its price competitiveness on these items by transforming itself into the formidable
global champion in terms of plant sizes and cost reductions. Park (2007) points out that China has taken
over Korea in the realms of the IT industry in the EU market with price competitiveness. It is also
anticipated that China may successfully catch-up with the automobile ancillary and petro-chemical
industries unless Korean entrepreneurs formulate and reinforces their corporate strategies for enhancing
core competencies in the niche markets. The intra-industry specialization plays critically important role in
the RTA in parallel with the fast pace of widening and enlargement of RTA like the EU. It may be an
ideal solution for both nations to strengthen intra-industry specialization for the case of automobile
industry by sharing their specialization realms in production activities, R&D ones and marketing
strategies on the basis of potential competitive advantages.
2. SWOT Analysis on the Automobile Industry
The global automobile market has been overhauling by the dominant market positioning of Japanese
automobile industry and the eroding competitive edge of the US automobile industry since the early 2000.
Toyota became the world champion by taking over GM on the global market in 2005. Another
development may be the increased importance of the Northeast Asia in terms of production and
consumption boosted by the automobile industries of China and Korea. The Hyundai automobile group
has implemented global marketing strategy gradually by carrying out FDI in China, India and Slovakia,
but its pace and scale of global marketing is still lagging behind as compared with the global leaders.
Despite having achieved its face pace of improving cost reductions and yield rates, it has to make a
further progress in bridging or closing the wedge in brand equity with the Japanese counterpart whose
major ingredients are the technology innovation, corporate social responsibility and the relationship with
interest groups.14
The automobile industry of China is in such a position of enhancing its competitive edge by making
use of its expanding domestic market. It can also enhance its technology capabilities and marketing
know-how by making use of the joint-venture companies with the global leaders in automobile industry.
14
Toyota of Japan may be the global champion in this aspect.
12
Under the present circumstances of global financial crisis and unstable world market, it may be necessary
for both Korea and China to pursue their corporate strategies and public policies which allows them to
accrue the agglomeration effect between market expansion and technological innovation. The SWOT
analysis of Table 3 is drafted to formulate corporate strategy of Korean automobile firms to materialize
such an agglomeration.
[Table 3] SWOT Analysis on Motorcar Industry of Korea and China
• Technology independence from MNEs and accumulation of production technology
• Price competitiveness by reducing production cost through the realization of economies of scale
K
and learning-by-doing
• Feasible production on the local demand with competitive advantage as a result of foreign direct
S
investment with optimal scale
• Fortified market positioning boosted by quality improvement
• Expanding domestic market with a fast pace
• Availability of abundant labor with low wage rates and the almost unlimited expansion of domestic
C
demand
• Joint-ventures with the leading global MNEs
• Procurement of energy resources abroad
• Relatively high defective rates and poor quality of after-service as compared with the Japanese
counterparts
• Low rate of penetration into the niche market due the vulnerable capability of marketing survey
• Sluggish progress in making a flexible adjustment towards the changing patterns in technology
innovation and market positioning
W K • High dependency ratio of imports of core components due to the slow progress in technology
acquisition and innovation
• Relatively low total productivity due to the unsettled implementation of flexible management
system
• Low utilization ratio caused by the frequent changes in new models
• Hostile labor relations which works as one of deterrent factors for autonomy of management
13
• High dependency ratio of core components abroad due to vulnerable technology, low level of
quality and the immature stage of in-house technology capabilities
• Cut-throat competition and diseconomies of scale due to the numerous entries of small firms
C
below the minimum efficient scale
• Slow progress in developing independent business models and relatively low accumulation of their
own operation performance
• Widening technology gap with the leading MNEs
• Located in the feasible contour of making innovation in product and management know-how if
motorcar firms successfully amalgamate technology and merchandizing
• Located in the possible zone of increasing the value-added and agglomeration effect if the relevant
firms successfully realize the cumulative causation effect between the expanding market and in-
K
house technology capabilities
• Expansion of the China and Southeast Asia markets which exhibit high growth rates
• Boosted marketing in parallel with the improved brand equity of the Korean motorcar firms
• Possible activation of marketing and outsourcing on those countries located around the Silk Road
O
by making use of the advertisement of the cultural heritage of Korea
• A possible acceleration of technological innovation boosted by the enhancement of in-house
technological capabilities based on the strong foundation of basic science
• Increased possibility of ancillary items with lower price tags by making use of the trend of global
C
outsourcing
• Proximity with the Southeast Asia which has latent potential for high growth rates
• Participation on the global supply chain of ancillary items by making use of their FDI into China
and the consequent possibility of exerting increased market power
• Vulnerable network between motorcar and ancillary firms
T K
• Possible discrepancies between marketing and R&D activities due to the immature stage of
localization
• Backlash effect on the preservation of core technology and in-house R&D capabilities due to the
14
deindustrialization facilitated by the expansion of production abroad
• Conflicts with the foreign investing firms with respect with the corporate governance
• Increase in the imported motorcar boosted by trade liberalization
• Dramatic up-surge of new technologies related to motorcar industry
C • Possible deindustrialization of domestic motorcar industry by the fast expansion of foreign
affiliates via FDI
• Contingent possibility of encountering financial crisis on the process of resolving the bad-debt
asset
Source: drafted by Dr. Chul Cho of KIET and Hae-du Hwang of SEI
3. Trade Specialization Index (TSI) of Ancillary Industry
The estimation of TSI of automobile industry for capturing the evolving comparative advantages
between Korea and China may be misleading because a substantial portion of Chinese output has been
delivered to the domestic market. The activities and performances of automobile exports are quite recent
phenomena. But China has become one of major producers of ancillary items and heavily involved for
export activities, thus, the TSI of ancillary industry of Table 4 can be used as a rough gauge for tracing
out the evolving comparative advantage between China and Korea. The ancillary industry plays important
role for evaluating the competitive edges of automobile industry. This trend has been fortified due to the
application of module production since the early 1990s. Acquino (1978) explains that the TSI of a
specific item can be estimated by dividing the difference of export or import amounts of this item with
other nation by the summation of export and import amounts. Table 4 demonstrates that there exist
significant scopes of intra-industry specialization in the ancillary industry by categorizing the
complementary or substitute functions of ancillary items on the basis of the TSI divergences or
convergences. It is also found that the Chinese ancillary industry has improved its comparative advantage
with a fast pace over the observed period. It is noticeable that both countries are rather sluggish in
improving their global market position of high value-added items such as gear boxes and clutches.
The automobile and its ancillary industries may be suitable industries to accrue the agglomeration
effect by making use of FDI for the joint research or global marketing. The FDI flows between Korea and
China may be reduced at the initial stage of KCFTA because the incentives to circumvent the tariff
barriers are dwindled due to the tariff exemption or reductions. But it may be quite possible to make a
reverse movement against this initial negative impulse if the combined effects of liberalization procedures
of service sector and FDI eclipse the effects of tariff reductions. The Korean firms of manufacturing and
service sector may successfully capture such a pivotal momentum to increase their business activities and
15
FDI in an improved business climate of increased legal stability. It can be, thus, gathered that such a
paradigm shift may contribute for the enhancement of competitive edges of Korean and Chinese
manufacturing and service sectors alike.
[Table 4] Comparison of TSI between Korea and China in Ancillary Industry
Korea’s TSI to World
China’s TSI to World
Commodity
2002
2004
2006
2008
2002
2004
2006
2008
Bodies for motor vehicles
0.988
0.982
0.938
0.673
-0.987
-0.884
-0.993
0.940
Bodies for other vehicles
0.984
0.951
0.950
0.565
-0.438
0.678
-0.974
0.937
0.290
-0.148
0.157
0.376
-0.346
-0.413
-0.998
0.185
Safety seat belts
-0.960
-0.767
-0.509
-0.248
-0.008
0.131
-0.998
0.584
Gear boxes
-0.924
-0.831
-0.789
-0.635
-0.807
-0.939
-1.000
-0.778
0.484
0.529
0.416
0.077
-0.745
-0.602
-0.998
0.256
-0.208
0.433
0.575
0.320
-0.352
-0.056
-0.995
0.423
0.396
0.388
0.365
0.374
0.359
0.362
-0.996
0.368
0.141
0.453
0.568
0.209
-0.863
-0.740
-0.999
-0.248
Bumpers and parts of the
motor vehicles
Drive-axles with
differential
Suspension shockabsorbers
Clutches and parts thereof,
of the motor vehicles
Vehicles of parts, steering
wheels, steering columns
Source : estimated by the author by making use of data for the KITA
N.B : The ancillary classification is based on the HS8707.
4. Corporate Strategy and Public Policy for Materializing Agglomeration Effect
It may be required for Korea and China to prepare an overall configuration of cooperation roadmap for
developing the intra-industry specialization towards production sharing. Such endeavor may allow the
development and expansion of specialized fields by extending the time and space horizons without
incurring the volatile negative impulses of credit or consumer crunches. It may be ideal to cooperate in
regional or global marketing and to have a joint research programs to appropriate the positive spillover
effects from the joint R&D. The Beijing affiliate of Hyundai motorcar group has achieved its aims of
increasing its shares in the Beijing taxi market in 2008 while transferring the product and production
technology of medium-sized car models on which it had accumulated the relevant core technology
independently.
16
The corporate strategy plays an important role in the monopolistic market which is featured by the
product differentiation and learning-by-doing. Proponents of new economic geography also posit that the
corporate strategy will resume critically important role in parallel with the realization of the cumulative
causation effect between technology and market expansion. It may be highly improbable for the Korean
and Chinese automobile firms to fortify their brand equities if they fail to reach a tacit agreement to
promote intra-industry specialization. Such a pattern of cooperation with mutual consultation may
contribute for curtailing their excess capacities by incurring the minimal frictional cost. The strategy of
combining the marketing know-how, R&D and finance also plays important roles as a means of avoiding
the chasm marketing for those products which requires a huge R&D expenses with short product life
cycles.15 It may be also equally important to operate competitive intelligence for the technology roadmap
and marketing strategy of rivalry firms for achieving a dynamic efficiency.
The public policy from the perspective of the NEG, attaches its utmost importance on nurturing for the
provision of infra-structure for inducing a sequence of technology innovation. Such a public policy differs
from those policies based on the balanced growth theory or unbalanced growth theory which emphasize
the external effects of providing social overhead capital or the linkage effects with the up or down-stream
activities. It also differs from the industrial policy which restrains the collusive activities with the antitrust policy by analyzing the structure, conduct and performance because its stance is to nurture the
overall business environment for boosting a sequence of technology innovation for market expansion.
The public policy of Korea toward automobile industry is required to focus on intra-industry
specialization which aims at for the alleviation of overlapping industrial capacity and the enhancement of
global marketing capability. The backbones for such an intra-industry specialization are the joint R&D
activities, pooling human resource development and management and the reinforcement of intellectual
property right on industrial innovation. Such a need for intra-industry specialization becomes more acute
if one fully admits that the long run competitive edges of a nation or economic bloc may be largely
determined by the different development stages of the national or economic bloc system of industrial
innovation. Put this in another way, the polarized version of malfunctioned public policies between Korea
and China may be ended up with the increase in excess capacities and the increased redundancies of labor
forces caused by the misalignment of manpower policy which impairs the competitive edges and market
positioning in the global market. The ‘Myth of the Asia’s Miracle’ of Krugman (1994) can be one of the
typical cases of pointing out such a polarized version of extensive pattern of growth. Both Korea and
China are shifting toward the intensive one but the pace is rather sluggish in the up-market and
technology-intensive service industries.
It is recommended for both nations to resolve the pending issues in international relations and
collective defense system which have worked as one of impediment factors of making a further expansion
15
The chasm marketing refers to such cases in which producers fail to realize cash flows which may be sufficient to cover the
sunk cost of R&D and marketing expenses due to the wedge between R&D and marketing.
17
of trade, investment and technology cooperation. It is also suggested from the deepening, widening and
enlargement of the EU that a federal RTA may be more effective in achieving the industrial and
technology cooperation. One possible way of making progress in this realm comprises the comprehensive
FTA which can be the cornerstone of developing the frontiers of public economics or public law by
distilling the federal attributes of economic integration. The improved market positioning of Airbus in
2003 and in 2004 as compared with the Boeing or the Lisbon Strategy which aims at facilitating the
knowledge-based economy for the period 2000-1010 well exemplify such cases. The ‘Lisbon strategy’ of
the EU aims at reducing the digital divide with the United States, thus, it can be interpreted as an
extension of common industrial and technology policy in order to achieve high economic growth rates as
well as accommodating the ‘European Social Model’.
V. Concluding Remarks
This research analyzes the economic effect of KCFTA in the context of a multi-track trade policy. The
purpose is to formulate corporate strategy and public policy as a way to increase consumer welfare and
enhance the industrial structure of Korea. A salient facet of this research may be its attempt to
amalgamate the regional trade agreement and the NEG, shedding light on the critical importance of the
agglomeration effect and intra-industry specialization for the adjustment process towards the launch of
KCFTA. It also traces out the new attributes of the FTA which exhibits a full accommodation of FDI, the
liberalization of service sector and the preemptive movement for capturing expanding foreign markets. It
covers as well the important role of corporate strategy as a means of achieving product differentiation by
facilitating R&D and marketing activities.
Most previous studies on the KCFTA at the aggregate level show that Korea may accrue some positive
effect from the creation of trade and dynamic gains in the technology intensive manufacturing sector.
They also demonstrate that small and medium-sized firms and the agricultural sector of Korea may suffer
from the negative effects of high industrial adjustment costs. The positive effects for Korea may go away
due to the high ratio of processed patterns of trade with China. This research keeps a certain distance from
the previous studies, which emphasize welfare gains without fully taking into account the process of
industrial adjustment. Instead it attaches the utmost importance on the attempt to cooperate at the intraindustry level specialization with China.
The competitive edge of the automobile industry is primarily determined by the blend of capital,
technology, brand equity, and marketing. With its production and architectural technology, the Korean
automobile industry is in a position to transfer the relevant technologies for medium-sized vehicles to its
Chinese counterpart at competitive prices because it has successfully accumulated generic technology in
this area. The Chinese automobile industry could successfully achieve a great leap-forward in the spheres
of product technology and marketing know-how by taking full advantage of its strategic alliance with
global leaders. The Korean counterpart may provide the production technology at a competitive price.
18
A competitive advantage analysis based on the SWOT model demonstrates that there are ample
scopes of mutual cooperation between China and Korea. The intra-industry specialization in the ancillary
industry, in which Korea specializes in technology-intensive items whereas China focuses on laborintensive ones, exemplifies such a typical case of corporate strategy at present. It is also required to adopt
public policy that nurtures the human resource development and the R&D capabilities as a means of
accruing some synergistic effect from intra-industry specialization. Such a combined approach of
corporate strategy and public policy may be effective in reducing the inherent uncertainties arising from
the R&D and global marketing activities in the volatile economic climate exacerbated by the global
financial crisis of 2008.
This article highlights the possibility of amalgamating the new economic geography and economic
integration at a toddler’s stage. The empirical verification at the industry specific level seems to be
beyond the scope of this research because it requires enormous endeavors of setting up econometric
model and collecting the relevant raw data at the sector specific levels. It is hoped that the forthcoming
research will resume this unfinished work.
[References]
Amiti, Mary, 2005, ‘Location of vertically linked industries: agglomeration versus comparative
advantage,’ European Economic Review, Vol. 49, No. 4, pp. 809-832.
Aquino, Antonio, 1978, ‘Intra-industry trade and inter-industry specialization as concurrent sources of
International Trade in manufactures,’ Review of World Economics, Vol. 114, No. 2, pp. 275-296.
Audretsch. David B., 1998, ‘Agglomeration and the Location of innovative activity,’ Oxford Review of
Economic Policy,’ Vol. 14, No. 2, pp. 18-29.
Chambers, Michael R., ‘The Chinese and the Thais are Brothers: the evolution of the Sino-Thai
friendship,’ Journal of Contemporary China, Vol. 14, No. 45, pp. 599-629.
Cowling, Keith and Roger Suden, 1996, Capacity, Transnationals, and Industrial Strategy, in Creating
Industrial Capacity, eds. Miche, Jonathan and John G. Smith, Oxford, Oxford University, pp. 209307.
Duranton, Gilles and Michael Storper, 2006, ‘Agglomeration and growth: a dialogue between economists
and geographers,’ Journal of Geography, Vol. 6, pp. 1-7.
Hwang, Yoon-jin, 2006, ‘Industrial Adjustment of Korean Petrochemical Industry toward the
Development Strategy of China,’ KIET Issue Paper 2006-212, KIET, Seoul. [In Korean]
Hwang, Hae-du and Xiangshou Yin, 2008, ‘Recent Development of RTA in North East Asia.’ Asia Europe
Journal. Vol. 6, No. 3, pp. 455-466.
Hwang, Hae-du and Bernadette Andreosso-o’Callaghan, 2009, ‘Energy Cooperation and Emerging
Regionalism in North-East Asia: Relative Impact on APEC and ASEM in Terms of InterRegionalism,’ Journal of Korea Trade, Vol.13, No. 1 pp. 65-88.
19
Krugman, Paul, 2004, ‘The Myth of Asia’s Miracle,’ Foreign Affairs, Vol. 73, No. 3, pp. 62-78.
Lee, Chon-Pyo, 2009, ‘Notable Features of 2008 Financial Crisis and Directions of Adjustment by the
Korean Economy,’ Seoul Journal of Economics, Vol. 22, No. 2, pp. 181-215.
Lee, Hyun-hoon, 2007, ‘Impact of Liberalization of Service Sector on the Economic Growth and
Productivity,’ Economic Development Studies, Vol. 13, No. 1, pp. 67-94. [In Korean]
Lee, Jang-kyu, Ingu Lee, Jina Yeo and Hyunjun Cho, 200, FTA Strategy of China and Its Policy
Implication, Research Report 06-01, KIEP, Seoul. [In Korean]
Lee, Hanggu, Cho, Chul, Lee, Youngju and Kyungyu Kim, 2004, ‘The Shift of Global Position of
Chinese Motorcar Industry and the Cooperation Road Map in Automobile Industry between Korea
and China,’ Research Report 04-12, KIET, Seoul. [In Korean]
Palley, Thomas I., 2006, External Contradictions of the Chinese Development Model: export-led growth
and the dangers of global economic contraction, Journal of Contemporary China, Vol. 15, No. 46,
pp. 69-88.
Park, Hynngsung, Huh, Jin-seok, and Sanggyu Lee, 2008, ‘Recent Features and Prospect of Investment
Patterns to Steel Capacity Expansion,’ POSRI CEO Report 08-07, POSCO Management Research
Center, Seoul. [In Korean]
Park, Pil-jae, 2008, ‘Comparative Analysis on the Export Competitiveness among Korea, China and Japan
in the EU market,’ Research Report 08-07, Korea International Trade Association, Seoul [In
Korean]
Yang, PyoungSeob, ChangKyu Lee, Hyunjeng Park, Jina Yeo, SengBin Pae and HyunJun Cho, 2007,
‘Characteristics of the Trade between Korea and China and the Implications for a Korea-China
FTA,’ Research Report 07-08, KIEP, Seoul. [In Korean]
IEA, Annual Report of Oil Corporation of Major Nations, 2007